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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Oil Market Tightens But COVID-19 Could Spoil The Rally

Global oil demand has rebounded somewhat faster than previously thought, although the spread of the coronavirus in the United States and Latin America is “casting a shadow over the outlook,” the International Energy Agency (IEA) wrote in its latest Oil Market Report. The last few weeks have seen crude oil prices trade in a “remarkably stable” trading range, and according to the futures market, traders anticipate that the historic surplus seen in the second quarter will give way to a deficit in the second half of the year. 

Global oil demand declined by 10.75 million barrels per day (mb/d) in the second quarter, the IEA confirmed. That should improve to down only 5.1 mb/d in the second half of the year as large parts of the globe bounce back from lockdowns. In fact, the IEA revised up its forecast for full-year demand to 92.1 mb/d, which is roughly 0.4 mb/d higher than last month’s report.

The reason? The sharp drop in demand during the second quarter wasn’t quite as bad as previously thought.

The market may also tighten a bit more than expected because of the declines in supply. OPEC+ stepped up compliance last month with the production cut agreement, achieving a 108 percent compliance rate. That contributed to a 2.4-mb/d global supply reduction in June compared to a month earlier, pushing global oil production down to 86.9 mb/d, a nine-year low. The market is thought to be in a supply deficit, albeit with a massive inventory overhang. 

Tightening demand and falling supply help explain the rally in oil prices from negative territory in April to a more solid trading range around $40 per barrel by late June and into the middle of July. 

For now, the fundamentals still point in this tightening direction. The IEA warned that U.S. supply could bottom out and resume growth, which would prevent prices from rising too much. But a record low rig count and steep decline rates from shale wells may yet translate into a further drop in output later this year. If shale rebounds, that could cap the rally, but if shale disappoints, that points to tightening. 

A more immediate threat to $40 oil is the return of some 2 mb/d of OPEC+ production cuts beginning as soon as August. Libya may also return some oil to the market after lifting force majeure on its oil exports. The one-month extension expires and the cartel has hinted that it would ease cuts next month, although nothing is for certain, and the group could still decide to extend again. 

Related: Can India Really Shut Down Oil Supply To China?

In fact, despite the obvious desire from some producers to lift production again, the very downside risks that the IEA is warning about may cause the OPEC+ coalition to think twice. “For the time being…OPEC’s strategy for controlling the market appears to be working,” Commerzbank wrote in a note. “An official letter has been received from Angola in which it commits to complying with the agreed production quotas and to implementing an additional cut to compensate for the recent overproduction.” 

With all producers stepping up compliance and stability returning to the market, OPEC+ would risk undoing those gains by loosening the cuts. More will be revealed in the coming days and weeks. 

Commerzbank cautioned about downside risks, but struck a bullish note, arguing that “the oil market is likely to tighten in the second half of the year thanks to the massive production restrictions and further recovering demand.”

Ultimately, however, so much is unknown because of pandemic. Gasoline demand continues to edge up in the U.S., although it remains below pre-pandemic levels for this time of year. “The resurgence of the virus could trigger a more intensive use of cars to avoid public transportation and more home deliveries to avoid crowded shops. This would be supportive for fuel demand,” the IEA said. “On the other hand, the resurgence could simply reduce mobility. The impact of the recent tightening is just starting to appear in mobility data for some countries, while mobility indices elsewhere show a gradual return to pre-Covid-19 levels.” 

It’s a mixed bag, but the IEA warned that the coronavirus could spoil the rally. “While the oil market has undoubtedly made progress since ‘Black April’, the large, and in some countries, accelerating number of Covid-19 cases is a disturbing reminder that the pandemic is not under control and the risk to our market outlook is almost certainly to the downside,” the agency said. 

By Nick Cunningham of Oilprice.com

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Leave a comment
  • Mamdouh Salameh on July 12 2020 said:
    The momentum of accelerating global demand will continue as the estimated demand destruction of 30 million barrels a day (mbd) caused by the COVID-19 pandemic has been revised downward by some accounts to under 16 mbd. I am sure it will decline further as the global lockdown continues to ease, OPEC+ production cuts continue to hold and China’s crude oil imports continue to roar. And to make things tighter in the market, US shale oil production will be struggling to even produce 7 mbd this year and the coming 3 years.

    Based on these bullish trends, I have calculated that global oil consumption this year will average 98.34 mbd, just 3 mbd less than the 2019 average of 101.34 mbd. Moreover, oil prices could be expected to hit $45-$50 a barrel in the second half of this year and touch $60 in early next year.

    Still, the global oil market could be headed towards a major supply deficit estimated at 10-15 mbd sometime in 2022/23 sending oil prices rocketing above $100.

    Many major factors could contribute to this impending deficit prominent among them the virtual collapse of US shale oil production, China’s unquenchable thirst for oil and a huge decline in global investments in oil exploration and production.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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